Submissions - Law Council of Australia
[On Law Council of Australia letterhead]
Mr Malcolm Turnbull
Dear Mr Turnbull
Managed Investments Act Review
The Corporations Committee of the Law Council of Australia (the Committee) welcomes this opportunity to provide its submission on the regulatory arrangements introduced by the Managed Investments Act 1998 (MIA) and contained in Chapter 5C and related provisions of the Corporations Act 2001.
The Committee notes that, under its terms of reference, the Review is asked to determine (among other things) whether `refinements could be made (whether requiring legislative amendment or not) to enable the arrangements to operate more efficiently and effectively, while not unnecessarily detracting from the protection afforded to investors'. Our submission focuses on this aspect of the terms of reference.
The Committee believes that the current regulatory arrangements would be enhanced by the following refinements:
A procedure for scheme amalgamations and reconstructions should be introduced, based either on the procedure for schemes of arrangement between companies and their members, or on the successor fund transfer arrangements in the Superannuation Industry (Supervision) Act 1993 (SIS).
The related party transaction provisions in Part 5C.7 should be simplified, by breaking the current drafting nexus with Chapter 2E of the Corporations Act and putting in place restrictions that are more appropriate for trust-based investment arrangements than the current law.
The requirement for an extraordinary resolution to approve a replacement responsible entity should be removed and replaced with a requirement for a special resolution.
To facilitate the management of troubled schemes, Chapter 5C should allow for the appointment of a registered insolvency practitioner as temporary responsible entity.
To achieve greater certainty as to the responsibilities, obligations and liability of responsible entities and others involved in operating schemes, the current inconsistencies between s 601MA and s 1325 should be resolved.
Some members of the Committee also believe that the role of the compliance committee should be re-examined.
The submissions are explained below. At this stage, we have not provided detailed technical arguments or drafting recommendations in support of our submissions. However if this would be of assistance to the Review we would be happy to do so, either by further written submissions or in person.
1. Scheme amalgamations and reconstructions
The Committee believes that the efficient operation of the managed investments industry would be enhanced by the introduction of arrangements to facilitate the amalgamation or reconstruction of registered schemes.
In 1997 the Financial System Inquiry (FSI) concluded that:
From the fragmented and partly contradictory evidence presented to the Inquiry, it appears that operating costs in Australia's funds management sector are relatively high .... Submissions noted a range of reasons for the high cost of funds management in Australia [including]:
lack of competition due to taxation disincentives;
lack of low cost distribution channels for unit trusts; and
industry structure, namely the large number of small funds, which creates scale diseconomies and the large share of funds held in retail rather than wholesale funds.
There is, at present, no statutory procedure for amalgamating or reconstructing registered schemes. The ability to amalgamate or reconstruct registered schemes with certainty would assist the industry in resolving these structural problems identified by the FSI.
Under the present law, it is possible to effect an amalgamation or reconstruction through an informal scheme of arrangement carried out by amendment to the scheme's constitution. Such an amendment requires the approval of a special resolution of members. However, responsible entities who carry out amalgamations and reconstructions on this basis are exposed to some degree of uncertainty. The lack of a clear statutory procedure leaves the the way open for challenges to amalgamations and reconstructions of the kind made in Cachia v Westpac Financial Services Limited (2000) 18 ACLC 293.
If the Review accepts our submission that there is a case for a statutory reconstruction or amalgamation procedure, there are two models available. The first is a model requiring the consent of a majority of members (probably a special majority) of the scheme or schemes to be amalgamated or reconstructed. This procedure could reflect the scheme of arrangement provisions that apply as between companies and their members under Part 5.1 of the Corporations Act.
The second alternative does not involve member consent. A responsible entity is subject to equitable and statutory obligations to act in the interests of members. In light of this, it would be possible to put in place a procedure whereby a responsible entity, if it believed it to be in the best interests of members, could effect a reconstruction or amalgamation of the scheme without the consent of members. This approach underlies the successor fund transfer provisions in SIS, which allows superannuation funds to be merged without requiring the consent of beneficiaries, where they have equivalent rights and entitlements in the merged fund.
The Committee favours the first model.
2. Related party transactions
The Committee has serious concerns about both the policy underlying, and the operation of, the current Part 5C.7.
Part 5C.7 attempts, by modification of certain provisions, to apply the related party transaction rules in Chapter 2E of the Corporations Act to registered schemes. It is not clear that it is appropriate (given the differences between schemes and companies, and the legal bases on which they operate) for self-dealing by a responsible entity to be regulated on this basis. Further, applying a modified Chapter 2E makes the requirements complex and difficult to administer. Finally, the Committee believes there are significant drafting problems with Part 5C.7 that produce legal uncertainty and impact adversely on member protection.
In the Committee's view, a responsible entity of a registered scheme should not be permitted to confer a financial benefit on itself or a related party of it unless:
the benefit is conferred on arms length terms; or
the benefit is expressly permitted under the terms of the scheme constitution, and has been disclosed to members prior to being given; or
the benefit is conferred on the responsible entity or related party (as the case may be) in its capacity as a member of the scheme, and on terms applicable to members generally; or
the entity receiving the benefit is also owned by the members of the scheme (for example, in the case of stapled securities).
The Committee does not believe that, outside these limited circumstances, a financial benefit should be conferred by a responsible entity on itself or a related party with the approval of some but not all of the members, unless the constitution of the scheme is expressly amended to permit the benefit and the benefit is disclosed in advance.
The Committee believes that this approach will result in simpler drafting, fairer treatment for members, and greater certainty for responsible entities.
The Review may be interested to note that trustees of public offer superannuation entities are prohibited under SIS from transacting on other than arms length terms.
3. Extraordinary resolutions
Chapter 5C requires an extraordinary resolution of members to approve the appointment of a new responsible entity. This is so even where the responsible entity is being appointed on the recommendation of a retiring responsible entity.
An extraordinary resolution must be passed by at least 50% of the total votes that may be cast by members entitled to vote on the resolution (including members who are not present in person or by proxy). In practice, this voting threshold is proving impossible to meet.
In large schemes, the Committee understands that it is rare in a registered scheme for the total number of votes cast on a resolution (for or against) to reach 50%. Certainly this was the experience of a number of managers who were required to convene meetings of members to effect transition from the prescribed interest laws.
The practical difficulties in obtaining an extraordinary resolution make it difficult to achieve the orderly resignation and replacement of a responsible entity. The Committee suggests that the requirement be changed to from an extraordinary resolution to a special resolution.
4. Replacement responsible entities
Section 601FP provides for a Court to appoint a temporary responsible entity in certain cases, including where the incumbent has been removed by the members or when ASIC or a scheme member has applied to the Court for that to occur.
Under the present law, the person appointed as temporary responsible entity must meet the requirements in section 601FA (that is, it must be a public company that holds a dealers licence authorising it to operate a managed investment scheme). The Committee believes that, particularly in the case of troubled schemes, this requirement may be unrealistic. It may be more appropriate in some cases to give the Court the option of appointing a registered insolvency practitioner as temporary responsible entity.
One of the aims of the MIA was to ensure that lines of responsibility and accountability for the operation of the scheme would be clear. Section 601MA, which imposes civil liability on a responsible entity for breach of Chapter 5C in relation to the scheme, was intended to be the keystone of a `single' responsible entity structure.
However, section 601MA does not provide a single gateway for claims for breach of Chapter 5C. Section 1325 also applies in this case, giving standing to a wider class of claimants and providing a basis for civil liability to be imposed directly on any person engaging in a contravention of Chapter 5C (not just a responsible entity), and on any person who is involved in the contravention.
As a matter of law, it appears that section 1325 creates rights in the members of a registered scheme to bring action for breach of Chapter 5C by persons other than the responsible entity itself (including directors, compliance committee members and others). Section 1325 is clearly wider in its application than section 601MA.
Our view is that the concurrent application of the narrower section 601MA and the wider section 1325(2) to the same facts may create uncertainty over accountability. This impacts one of MIA's central aims, which was to ensure that lines of accountability and liability for the administration of schemes are clear.
We do not think that investors should be deprived of the wider remedies available to them under section 1325. As the operation of section 601MA appears to be completely subsumed by section 1325, the Committee suggests that section 601MA be repealed.
6. The compliance committee
We note also that some (but not all) members of the Committee believe that there may be some scope to re-examine the role of and requirements for compliance committees. Since the MIA commenced, ASIC has on occasions identified significant shortcomings with compliance committee structure and functioning. In some cases ASIC has required the responsible entity to appoint an external compliance consultant to monitor and report on the adequacy of a scheme's compliance plan, and its responsible entity's compliance with that plan.
In the Committee's view, there are significant questions that can be raised about the independence, accountability, resources and functioning of compliance committees. In light of these concerns it may be appropriate in some cases to allow the functions of the compliance committee to be performed by an external consultant that has the resources and expertise to provide those services. If it were considered appropriate, there could be a requirement that external compliance consultants be registered or approved by ASIC and carry appropriate insurance cover.
We will be pleased to provide more detailed submissions on these matters, or to meet with you to discuss the issues raised, if that would assist the Review in finalising its work.
P G Levy
25 September 2001
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